Indonesia’s Oil Policies Assisted by Falling Prices

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CEIC Indonesia Data Talk - May 25, 2015
The decline in oil prices could not have come at a more opportune moment for Indonesia’s President Joko Widodo. Lower oil prices have provided Mr. Widodo with the leeway to dismantle Indonesia’s gasoline and diesel subsidy schemes, which formed part of the administration’s election pledges. The Widodo administration increased regulated prices of gasoline and diesel in November 2014, effectively slashing the national fuel subsidy. This was subsequently followed by a further cap on the diesel subsidy and a complete removal of gasoline subsidy with effect from January 2015. Indonesia’s experience demonstrates the far-reaching impact of global commodity markets on public policies.
The subsidy removal is expected to have a material impact on the fiscal budget. In 2014, Indonesia’s energy subsidy bill amounted to IDR341.80 trillion, rising from IDR309.98 trillion during 2013. While the initial budget (approved in September 2014) outlined projected energy subsidies of IDR344.70 trillion (inclusive of the IDR276.01 trillion fuel subsidy), the removal of fuel subsidies resulted in a downward revision to IDR137.8 trillion (inclusive of the IDR64.7 trillion fuel subsidy). The vastly reduced subsidy bill has allowed for a strategic reallocation of these funds to capital expenditure (which was revised upwards from IDR174.70 trillion to IDR276.0 trillion). The revised budget also puts Indonesia on the path of long-term fiscal stability with a revised budget deficit of IDR222.5 trillion compared to IDR245.9 trillion previously.
Fiscal consolidation aside, the removal of fuel subsidies may help to reduce the current account deficit, especially given Indonesia's position as a net oil importer (oil contributed USD23.9 billion to the total current account deficit of USD25.4 billion in 2014), although its impact is partially softened by Indonesia's position as a net natural gas exporter (contributing a surplus of USD12.1 billion in 2014).
The effective removal of fuel subsidies has had its fair share of detractors, particularly from the middle classes. Protests have revolved around expected increases in the cost of living given the ensuing price increases. Inflation spiked to 6.23% year-on-year in November 2014 from 4.83% during the previous month, increasing further to 8.36% during December 2014, following large increases in the energy CPI, which rose from 10.34% to 15.85% and 24.37% from October, to November and December 2015. However, while heightened inflation was consistent with higher fuel prices, higher inflation was also associated with a gradual increase in core inflation, which crept up from 4.02% to 4.21% and 4.93% over the same period. This prompted Bank Indonesia (the central bank) to hike its policy interest rate by 25 basis points to 7.75% with effect on 19 November 2014.
While inflation has receded to within the 6-7% range since January 2015, it remains substantially higher than the 4%±1% corridor targeted by Bank Indonesia. Notwithstanding these higher-than-targeted inflation rates, Bank Indonesia reverted back to a 7.50% interest rate in February 2015 in anticipation inflation pressure would recede and to support economic growth (GDP grew in real terms by 5.03% in 2014, compared to 5.58% in 2013).
Despite broad-based support for Indonesia’s efforts at fiscal consolidation amid low oil prices, the administration may face an uphill battle in managing the fallout from the negative oil shock (should it persist), especially in other industrial sectors. While lower oil prices are typically positive for most industries, its effects are not uniformly distributed across the economy. Crude palm oil (CPO) prices, in particular, have seen some adverse impact as low oil prices have cut the demand for biofuel (which uses palm oil as its input). While targeted price support for biofuel and the introduction of an export tax on CPO has helped prop up CPO prices and subsidise the biofuel sector, these measures might come at the cost of Indonesia losing out on CPO market share to its rival producer, Malaysia.
As a relatively large economy, it may be overly optimistic to anticipate a uniformly positive impact of oil prices across all sectors in Indonesia, regardless of its policies. Indeed, the appropriateness of its policies may not necessarily be observable in the short-term (the removal of fuel subsidies may be unpopular, but crucial for credible fiscal consolidation). However, beyond pursuing economic growth, Indonesia faces the task of equitably distributing the gains from the various sectors within the economy to help cushion the adverse impact of low oil prices on other sectors. With its path set on fiscal consolidation, all eyes will be on Indonesia’s next steps in the reallocation of its fuel subsidies.
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